What category of investments should I look at?

We hope you read our previous blog and are all set to flex your financial muscle as we move into a fresh new financial year in April. To get the most out of your savings, you need to design your investment portfolio. Just like your diet and workout schedule depends on your target goal weight and training period, your optimal asset allocation will depend on your investment horizon and appetite for risk.

You must have heard about the risks associated with putting all your eggs in one basket. This age-old adage is extremely relevant in the context of your investment or ‘asset’ allocation as well. Asset allocation refers to budgeting your savings so that it is spread across a wide variety of ‘asset classes’- like equity, bonds and cash. This allocation will comprise of a varied mix of investments, ranging from aggressive to conservative holdings.

When you allocate your assets, you do so with an expectation that you will reach your pre-set financial goals - despite the associated risks. Each asset class has a risk associated with it and this is the risk-return analysis that you have probably heard of. Risk, in financial terms, refers to the possibility of a partial or total loss of your original investment.

Amongst all the asset classes, investment in equities has the potential to provide the highest return, but is also associated with the highest risk. On the other end of the spectrum, you will find Government bonds -with the least risk and lowest return. This is the risk/return trade-off and to insulate your portfolio from market shocks, a diversified portfolio is recommended.

Let us look at equities and try to rationalize the inherent fear of the investor with regard to equity investing. As a start, let us understand the meaning of the word ‘equity’. Simply put, it means ownership of an asset. However, there are different flavours of this term:

In the corporate world, ‘Equity’ refers to the amount of capital contributed by the owners.

When someone talks about ’Equity’ in a home loan, it means the difference between the property’s market value and the loan amount of debt still outstanding on the property.

In the world of investments, which we are right now talking about, ‘Equity’ refers to the shares or stock that you own in a company.

People who invest in equity, purchase shares of a company with the expectation that the value of the shares would rise, resulting in capital gains or dividends. The flip side is that the value of the shares could nosedive. A bit like gambling, isn’t it? That is why it is not surprising that equity has always been synonymous with risk. So, historically and rightfully, people view the suggestion to invest in equity with apprehension. We understand and acknowledge this inherent risk. However, equity is not only about the risk dimension. The scepticism about investing in equity stems from having heard about and read about investors whose investments faced considerable erosion due to the volatile equity markets.

As an equity investor, it does not follow that you will go down the same path. Would you stop lifting heavy weights in the gym because your friend sustained a ligament tear? We would not think so -we would assume that you would ask your trainer to prescribe a workout based on your BMI and physical fitness. And that is exactly what your Wealth Manager at WMU would do – coach you on equity investing, what you can expect, highlight the varying degrees of risk that are present in the different equity instruments and propose an investment plan commensurate with your risk appetite and investment goal.

Within the Indian equity market, there are different equity products with different levels of risk. There are Equity Mutual funds, Equity Portfolio Management Services (PMS) and direct stocks. Let us briefly understand each one in ascending order of the risk index.

The least amount of risk is associated with equity mutual funds since these are:

  • Managed by an active Fund Manager who has expert back-up of a research and analysis team.
  • The number of stocks in each fund can range between 40 to 80 which allows for diversification. This reduces the risk of holding only one single stock (remember – all apples in one basket?).
The next one would be the Equity PMS. This essentially, is quite similar to the Mutual Fund, except that the PMS Fund Managers hold a more concentrated portfolio of 10-25 stocks. The risk is inherently higher but has the strong backing of the Fund Manager’s conviction based on rich experience and the research team in the strategy they deploy. The SEBI’s regulatory requirement of a minimum of INR 50 Lakhs for the PMS fund also helps mitigate risk to a large extent. There are also investment advisors who advise and you buy stocks or a portfolio of stocks on your own.

The third option is investment in direct stocks. This would mean you buy individual stocks as an investor. There is no fund manager or research team, there is just you-the investor- taking a calculated risk on different companies listed on the stock market. This requires significant time and thorough knowledge of the markets and one needs acumen to understand how a particular company operates, creates value for its investors and how market responds to it.

Some questions that you probably would ask yourself before buying into a company’s stock:
Should I invest in the stocks of a large, well established company that has a reassuring, steady growth curve?
Or should I invest in a small, new company with immense growth potential? Or something in between?
As you probably observed, the risk potential goes down as companies move up the market cap ladder.

To sum up our approach towards equity, investment in diversified equity can strengthen a portfolio’s performance by adding diversification and can be an option for everyone. As long as you opt for an appropriate medium of investing in equity based on your risk profile and have a right time horizon you will definitely progress towards a healthy style of investing in equity markets. Creating wealth in equity is all about having proper investment discipline and enormous patience. Warren Buffet once said, “stock market is a machine which transfers money from impatient to patient.”

Happy investing